STArTinG A BuSineSS in MinneSoTA

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1 A Guide To STArTinG A BuSineSS in MinneSoTA Small Business Assistance Office Minnesota Department of employment and economic Development

2 A Guide To S TA r T in G A Bu S in e SS in M in n e S o TA is updated annually. Copies are available without charge from the Minnesota Department of Employment and Economic Development (DEED), Small Business Assistance Offce, 1st National Bank Building, 332 Minnesota Street, Suite E-200, St. Paul, MN Telephone: (651) or (800) Fax (651) Website: mn.gov/deed/business/help/sbao/ Upon request, this publication can be made available in alternative formats by contacting (651) The Minnesota Department of Employment and Economic Development is an equal opportunity employer and service provider.

3 A Guide To STARTING A BUSINESS IN MINNESOTA Thirty-second Edition, January 2014 Charles A. Schaffer Madeline Harris Mark Simmer Copyright 2014, Minnesota Department of Employment and Economic Development ISBN

4 PREFACE This thirty-second edition of A Guide to Starting a Business in Minnesota, like its predecessors, is intended to provide a concise, summary discussion of the major issues faced by those starting a business in Minnesota. This edition of the Guide contains three major sections: the narrative text; a Resource Directory, which provides addresses, telephone numbers, and website addresses of organizations referenced in the text; and the Directory of Licenses and Permits, which lists all business licenses and permits required by the State of Minnesota, the state agency which issues or administers the license or permit, and a telephone number for obtaining more information. Topics presented in the narrative text are presented in the order in which the new business owner typically must address them. Note that a business that will have operations or a physical presence (with the possible inclusion of an Internet presence) in another state should check with the government authorities in that state to obtain information on licensing, tax and other issues. We hope this organization is useful. While no one publication can answer every question for every kind of proposed business, this Guide does respond to the questions and concerns most frequently raised. While it tries to be both timely and comprehensive, this Guide is not intended as a final statement on any one subject. In particular, users should be aware that the formal legal requirements for business start-up and operations may change from time to time. Specific updates and additional information may be obtained from the many sources listed. Before engaging in any business venture, it is advisable to seek both legal counsel and advice from an accountant. Both professionals can advise you as to the best course you might take in establishing your business. The information provided in this Guide is not intended to replace that kind of advice and assistance. We would like to thank Millie Caballero for her numerous contributions to the compilation of this Guide. Charles A. Schaffer Madeline Harris Mark Simmer i

5 TABLE OF CONTENTS Preface... i Choosing the Form of Business Organization... 1 Tax and Non-Tax Considerations... 1 Naming the Business Entity Forming a Sole Proprietorship Forming a Partnership Forming a Minnesota Business Corporation Forming a Minnesota Limited Liability Company Special Types of Business Organizations Filing Documents with the Offce of the Minnesota Secretary of State Secretary of State Fee Schedule Regulatory Considerations Securities Registration Franchise Registration Evaluating a Business Opportunity Business Licenses and Permits Environmental Protection Programs Access to the Regulatory Process Intellectual Property Protection Business Plan Accounting for the New Business Basic Accounting Principles Income Forecasting Techniques Business Grants Business Loans Public Sources of Financing Federal Programs Public Sources of Financing State Programs Public Sources of Financing Local Programs Private Sources of Funds Insurance Issues for Employers Who is an Employee? Employment Agreements Labor Standards Rest Breaks and Leave Time Employee Testing and Background Checks ii

6 Employment of Minors Protection of Employees Who Report Violations of Law Human Rights Immigration Law Compliance Occupational Safety and Health Workers Compensation Insurance Employee Benefits Plant Closings Poster Requirements Checklist for Hiring an Employee Business Taxes Tax Identification Numbers Business Income Tax Returns Sales and Use Tax FICA Tax Income Tax Withholding Successor Liability for Certain Taxes When a Business or its Assets are Transferred Revocation or Prevention of License Issuance or Renewal Unemployment Insurance Taxes Federal Tax Requirements State of Minnesota Tax Requirements Sources of Information and Assistance State Programs Small Business Assistance Offce Small Business Development Centers Minnesota Trade Offce Minnesota Business First Stop Vocation Rehabilitation Service Employment and Training Programs University of Minnesota Extension Minnesota Job Skills Partnership Dislocated Worker Program Minnesota Federal Bonding Service Government Procurement Assistance Accounting and Tax Assistance Libraries Additional Sources of Assistance Specialized Legal Research and Assistance Management Assistance for Minority Businesses Incubators Inventors Resources Minnesota State Colleges and Universities (MnSCU) Regional Development Commissions Export/Import Assistance SCORE Association Offce Women s Business Center iii

7 Resource Directory Cooperatives Environmental Export/Import Assistance Financing, Federal Sources Financing, State Sources Financing, Local Sources Financing, Private Sources Government, Federal Government, State Government, Regional Insurance Inventors Job Service and Job Training Legal Assistance Libraries Local Assistance for Small Businesses Management Assistance, General Management Assistance for Minority Businesses Procurement/Purchasing/Certification Assistance Tax and Accounting Assistance Additional Resources Directory of Licenses and Permits Index iv

8 CHOOSING THE FORM OF BUSINESS ORGANIZATION TAX AND NON-TAX CONSIDERATIONS INTRODUCTION One of the fundamental initial decisions a new business owner faces is choosing the form of organization for the business. Generally speaking, a person should consider himself or herself to be in business once they have begun the operation of an activity for which they expect to be paid. This is true whether or not that person terminates other employment (such as a job that brings a paycheck), or intends to operate that business on a seasonal or short-term basis. For most businesses, the choices are: Sole Proprietorship. In a sole proprietorship, the business is owned and controlled by one individual. This person alone receives the profits and bears the losses from the business, and this person alone is responsible for the debts and obligations of the business. Income and expenses of the business are reported on the proprietor s individual income tax return, and profits are taxed at the proprietor s individual income tax rate. If a husband and wife wish to own a business together, they must either form a partnership, corporation or limited liability company (in order to have each of them be an owner of the business) or a sole proprietorship (in which case only one of them will be an owner of the business). A married couple who jointly operate an unincorporated business and who file a joint federal income tax return may have a qualified joint venture and can elect not to be treated as a partnership for federal tax purposes provided that the husband and wife are the only members of the joint venture and that both husband and wife materially participate in the running of the business. In this case each spouse will report his or her share as a sole proprietorship. Partnership. A general partnership is a business owned by two or more persons who associate to carry on the business as a partnership. Partnerships have specific attributes, which are defined by statute. All partners in a general partnership share equally in the right, and responsibility, to manage the business, and each partner is responsible for all the debts and obligations of the business. Distribution of profits and losses, allocation of management responsibilities, and other issues affecting the partnership usually are defined in a written partnership agreement. Income and expenses of the partnership are reported on federal and state information tax returns, which are filed by the partnership. The partners are taxed on their respective share of the partnership s profits at their individual income tax rates. Minnesota partnerships are formed and governed only by the Revised Uniform Partnership Act (RUPA), Minn. Stat. 323A. Partnerships formed under former partnership law are now subject to this chapter. If you were formed under former laws and have not yet consulted with an attorney about the changes in partnership law, you are encouraged to do so immediately. 1

9 A limited partnership is a type of partnership in which the limited partners share in the partnership s liability only up to the amount of their investment in the limited partnership. By statute, the limited partnership must have at least one general partner and one limited partner. The general partner has the right and responsibility to control the limited partnership, and is responsible for the debts and obligations of the limited partnership. In Minnesota, a limited partner may participate in the management and control of the limited partnership without losing limited liability protection but does not have the power to act for or bind the limited partnership. Limited partnerships must be established in compliance with statutory requirements, including requirements of tax and securities laws. Because of their complex nature, limited partnerships should not be undertaken without competent professional advice. Limited Liability Partnership. A general partnership may register as a limited liability partnership (LLP) by filing a limited liability partnership registration. In limited liability partnerships, the personal assets of the partners are shielded against liabilities incurred by the partnership in tort or contract situations. This is different from a non-llp general partnership, in which partners may be personally liable up to an unlimited extent for the debts and obligations of the partnership. It should be noted that limited liability partnerships are a relatively new type of entity and certain aspects, such as tax aspects, of such entities are not yet fully developed or understood. Limited liability partnership status affords protection to the individual partner from liability for partnership obligations in tort and contract. An LLP files with the Secretary of State an annual report. There is a one-year grace period for retroactive reinstatement after revocation of LLP status for failure to file the annual report. There is an additional provision allowing a limited partnership to elect limited liability partnership status under Minn. Stat. 323A. This allows for limited liability protection for both general and limited partners and this type of partnership is called a limited liability limited partnership. Limited liability limited partnerships are discussed below. Care should be taken in naming a limited liability limited partnership; the name must contain either, the words limited partnership, limited liability partnership (or the abbreviation L.P., L.L.P. or the words limited liability limited partnership (or the abbreviation L.L.L.P. ). It is important to note that if a limited liability limited partnership chooses the L.L.L.P. designation, that partnership should also use that designation in its name as listed on its certificate of limited partnership. There are two reasons for this. First, without doing so, the Secretary of State might not accept the partnership s Statement of Qualification, because it is not clear that the entities are one and the same. Second, there could be questions about what standard of personal liability to apply to the partnership and the partners, and what entity is responsible for the partnership s actions, because the partnership s filings with the Secretary of State are inconsistent. Corporation. A corporation is a separate legal entity. It is owned by one or more shareholders. The corporation must be established in compliance with the statutory requirements of the state of incorporation. The shareholders elect a board of directors which has responsibility for management and control of the corporation. Because the corporation is a separate legal entity, the corporation is responsible for the debts and obligations of the business. In most cases, shareholders are insulated from claims against the corporation. 2

10 It is worth noting here that because a corporation is an entity separate from its owners, if the owner (and/or members of the owner s family) performs services for the corporation, these persons are considered to be employees of the corporation. Thus, the corporation will be required to comply with most of the laws and regulations and reporting requirements applicable to employers. The corporation may be taxed under Subchapter C of the Internal Revenue Code (a C corporation ) or be subject to the provisions of Subchapter S of the Code (an S corporation ). Minnesota tax laws provide for comparable treatment. A C corporation reports its income and expenses on a corporation income tax return and is taxed on its profits at corporation income tax rates. The Minnesota corporate franchise tax, sometimes called an income tax, is based on the income of a C corporation s income allocated to Minnesota. Profits are taxed before dividends are paid. The dividends are taxable income to the shareholders. Sometimes this is incorrectly referred to as double taxation. When instead it is two separate legal entities being taxed on their separate income. An S corporation election may be made by the shareholders of the corporation if the corporation meets the statutory requirements for S corporation status. The S corporation is taxed in much the same manner as a partnership, i.e., the S corporation files an information return to report its income and expenses, but it generally is not separately taxed. Income and expenses of the S corporation flow through to the shareholders in proportion to their shareholdings, and profits are allocated and taxed to the shareholders at their individual tax rate. Under the Internal Revenue Code, an S corporation may have only one class of stock, no more than 100 shareholders, and no shareholders that are nonresident aliens or non-individuals (e.g., corporations, partnerships, limited liability companies) except for certain estates, trusts, and certain tax exempt entities. The federal 2004 American Jobs Creation act allows an S corporation to treat shareholders within six generations of one family as one shareholder thus allowing family business S corporations to distribute shares to family members of existing shareholders without those new shareholders being counted as new shareholders against the 100 shareholder limit. S corporations are described in more detail in later sections of this Guide. A closely held corporation is any corporation whose shares are held by a relatively small number of shareholders. The Minnesota Business Corporation Act defines a closely held corporation as one which does not have more than 35 shareholders. Most closely held corporations are relatively small business enterprises, in which all shareholders tend to be active in the management of the business. Some states provide a separate, less formal, less restrictive set of laws for closely-held corporations. Minnesota does not. In Minnesota, the business corporation law is geared to small corporations, so a separate law is not necessary, and all corporations operate under one law. Limited Liability Company. A Minnesota business also may organize as a limited liability company. A limited liability company elects to be treated for tax purposes as a sole proprietorship (disregarded entity), partnership, or corporation. A limited liability company may have one or more members. As described further in the section on tax considerations in choosing the form of organization, organizers of Minnesota limited liability companies have some flexibility with respect to the federal income tax treatment of such entities due to the Treasury Regulations on entity classification. These Regulations appear in 26 C.F.R et. seq. A limited liability company with more than one member may choose to be taxed as a partnership or a corporation. In either event, the limited liability company must obtain both federal and state tax identification numbers, even if it has no employees. 3

11 A limited liability company with only one member may be taxed as a corporation or as a sole proprietorship. A limited liability company that chooses to be taxed as a sole proprietorship generally does not obtain a federal or state tax identification number unless it has employees in which case it will obtain tax ID numbers and use them to remit unemployment taxes. Business income and losses of the limited liability company that chooses to be taxed as a partnership or as a sole proprietorship may be passed through to the owners of the business. The income of a limited liability company that chooses to taxed as a partnership or as a sole proprietorship is included in the taxable income of the member or members and taxed at the owner s individual tax rate. Like a corporation, a liability for business debts and obligations generally rests with the entity rather than with the individual owners. A limited liability company is not subject to many of the restrictions that apply to S corporations. All members of a limited liability company may participate in the active management of the company without risking loss of limited personal liability. It is managed by a board of governors and an active manager. Other Forms of Organization. Other forms of organization available to Minnesota businesses include professional organizations, cooperative associations, business trusts, and certain variations of these forms of organization. These types of organizations are established and regulated by statute and involve complex legal, financial and accounting issues. Organizing under any of these forms should not be attempted without competent professional advice. Because of their highly specialized nature, these forms of organization are not addressed in detail in this Guide. Changing the Form of Organization. Note that although the discussion in the above paragraphs is also applicable when changing the form of business organization, (e.g., when converting a sole proprietorship to a corporation), a business owner is strongly urged to seek professional assistance when doing so, because unintended consequences may result. As an example, contracts entered into by the business may or may not be assignable to the new entity; also, there may be a tax cost to changing the form of organization, such as when an S corporation becomes a C corporation. Minn. Stat. 302A.681 authorizes conversions in either direction between corporations and limited liability companies. That section requires the converting organization to adopt a plan of conversion which must be approved by a majority of the board of directors or board of governors. Upon approval, articles of conversion are drafted and filed with the Secretary of State who issues a certificate of conversion and a certificate of incorporation or certificate of organization. There are similar requirements for the conversion or merger of partnerships and for the conversion of limited liability companies. NON-TAX FACTORS IN CHOOSING THE FORM OF ORGANIZATION In choosing the most appropriate form of organization, the business owner will want to consider a variety of factors, including: complexity and expense of organizing the business; liability of the business owner; distribution of profits and losses; management control and decision making; financing startup and operation of the business; transferability of ownership interest; continuity of the business entity following withdrawal or death of an owner; complexity and expense of terminating or reorganizing the business; extent of governmental regulation, and tax considerations. 4

12 These factors should be examined carefully in light of the objectives of the business owner. Competent legal, accounting and tax professionals can provide valuable advice and assistance in selecting the most appropriate form of organization. As with many business decisions, choosing a form of organization involves weighing the advantages and disadvantages of each alternative before selecting the form most appropriate to the business owner s situation. No one form of organization will be appropriate to all situations, and as the business expands a change in the form of organization may be necessary. The discussion which follows examines the differences in each of the above factors for proprietorships, partnerships, corporations, and limited liability companies. Complexity and Expense of Organizing the Business All businesses, regardless of their form, will encounter certain organizational costs. These costs can include developing a business plan, obtaining necessary licenses and permits, conducting market research studies, acquiring equipment, obtaining the advice of counsel, and other costs. Sole Proprietorship. The sole proprietorship is the simplest form of organization, and the least expensive to establish. There are no statutory requirements unique to this form of organization. From a regulatory standpoint, the business owner only needs to obtain the necessary business licenses and tax identification numbers, register the business name, and begin operations. Many individuals begin their business as a sole proprietorship. As the business expands or more owners are needed for financial or other reasons, a partnership or corporation may be formed. Partnership. A general partnership is more complex to organize than a sole proprietorship, but involves fewer formalities and legal restrictions than a limited partnership, corporation, or limited liability company. Basic elements of partnership law are established by statute, but most issues can be determined by agreement of the partners. A written partnership agreement is highly recommended, but is not legally required. Factors to consider in a partnership agreement are listed in a later section of this Guide. The partnership agreement is not required to be filed with any governmental entity. Note that under the Revised Uniform Partnership Act (RUPA) of 1997, Minn. Stat. 323A, partnerships have the option of filing with the Secretary of State certain statements regarding the authority and liability of partners as well as the status of the partnership. A limited partnership must meet specific statutory requirements at the time of organization, and the offering of ownership interests in the limited partnership is subject to tax and securities laws. Accordingly, the limited partnership will be more complex and expensive to organize than a general partnership. Limited Liability Partnership and Limited Liability Limited Partnership. An existing general partnership may elect limited liability partnership status by filing a limited liability partnership registration with the Secretary of State. Such registration is effective for an indefinite period of time. Limited liability limited partnerships are also permitted. Anyone interested in forming an LLP or an LLLP is advised to seek the advice of counsel. Note also under RUPA, limited liability limited partnership registrations have an indefinite term, although the Secretary of State will revoke LLP or LLLP status if the required annual registration is not filed. Limited liability partnerships generally follow partnership law with specific exceptions as provided by law. 5

13 Corporation. The corporation is a formal and complex form of organization, and accordingly can be expensive to organize. Procedures and criteria for forming the corporation and for its governance are established by statute. FAILURE TO FOLLOW THE STATUTORY FORMALITIES CAN RESULT IN LOSS OF CORPORATE STATUS AND IMPOSITION OF PERSONAL LIABILITY ON THE INCORPORATORS OR SHAREHOLDERS. The S corporation faces further complexity in that the election of S corporation status for federal tax purposes must be filed with the Internal Revenue Service in a timely fashion. In addition, care must be taken in the transfer of shares not to inadvertently lose S corporation status. Because of the complexities involved in incorporating, corporations often will make greater use of professional advisors, which will increase costs. Other costs associated with incorporating include filing fees, which are greater for corporations, and the costs associated with tax compliance and preparing various government reports. If the corporation does business in other states, it generally will be required to register to do business in those states, thus further increasing the cost and complexity of incorporation. And, if the corporation will raise capital by selling securities, the compliance costs involved will be substantial. Minnesota has attempted to simplify the incorporation process by including in the Minnesota Business Corporation Act all of the rules pertaining to the internal governance of the corporation. A corporation that agrees to be governed as specified in the statute need only file standard form articles of incorporation with the Secretary of State. The corporation that wishes to vary the statutory requirements generally must do so in its articles of incorporation. Prior consultation with legal counsel can assist the incorporators in determining which approach is most appropriate for the corporation. Further information on incorporating appears in the section of this Guide titled Forming a Minnesota Business Corporation. Limited Liability Company. The limited liability company combines aspects of the partnership and the corporation. It can be expected to be similar to a corporation in complexity and cost to organize. As with a corporation, the procedures and criteria for forming a limited liability company are specified by statute. FAILURE TO FOLLOW THE STATUTORY REQUIREMENTS CAN RESULT IN LOSS OF LIMITED LIABILITY COMPANY STATUS AND IMPOSITION OF PERSONAL LIABILITY ON THE ORGANIZERS AND MEMBERS OF THE COMPANY. There is very little case law to guide organizational and operational decisions although the limited liability company law is modeled on the business corporation law. For this reason, owners of a limited liability company may need to consult often with their professional advisors, increasing their costs. Under the Treasury Regulations dealing with the federal income tax classification of business entities, the organizers of a Minnesota limited liability company have some flexibility in choosing the tax status of their entity. Professional advice in this area is strongly encouraged. As is the case for Minnesota corporations, organizers of a limited liability company may agree to have the company governed by the provisions of Minn. Stat. 322B. In that case, standard form articles of organization may be used to organize the company. Further information on forming a limited liability company appears in the section of this Guide on Forming a Minnesota Limited Liability Company. 6

14 Liability of the Business Owners Sole Proprietorship. The sole proprietor is personally liable for the debts of the business, even if those debts exceed the owner s investment in the business. All of the owner s assets both those used in the business and personal property (subject to certain exemptions) can be attached by creditors and sold to pay business debts. The sole proprietor may be able to minimize certain risks such as property loss, personal injury or product liability by obtaining adequate insurance. Partnership. In a non-llp general partnership, each partner may be personally liable for up to the full amount of the debts of the business, even if the debts exceed the owners investment in the business. This is because, unless care is taken in the partnership agreement to limit a partner s authority and potential creditors are notified of the limitation, any partner may bind the partnership. The partner with greater personal assets thus risks losing more than a partner with fewer personal assets. As with a sole proprietorship, many business risks can be lessened by obtaining adequate insurance. However, in a Minnesota limited liability partnership, partners are not personally liable for the wrongful acts or omissions in the ordinary course of business of other partners, for the misuse of money or property of a non-partner by another partner, or for the debts or obligations of the partnership, subject to certain exceptions. It is uncertain how this kind of partnership will be treated in other states, although most states have adopted some form of limited liability partnership legislation. In a limited partnership, so long as the statutory formalities are met and the limited partner is not relied upon by others as a general partner, the limited partner generally is not liable for the obligations of the limited partnership. Thus the limited partner risks loss only up to the amount of his or her investment. The general partner retains full liability as in any other partnership. In limited liability limited partnerships general partners will enjoy the same protections from liability enjoyed by limited partners. Corporation. The corporation is a separate legal entity, and in most cases is the entity that is liable for the debts of the business. The shareholders generally are exempt from personal liability for those debts and thus risk loss only up to the amount of their investment in the corporation. This is the case for both the C corporation and the S corporation. It should be noted, however, that in a small, closely held or newly created corporation without an established credit history, some or all of the shareholders may be expected to personally guarantee repayment of certain corporate debts as a condition of obtaining a loan or credit. Also, under certain circumstances such as fraud or personal wrongdoing, shareholders may be held personally liable for wrongful acts. Finally, it is possible for courts to disregard the corporate entity and make shareholders liable under certain circumstances. See the Withholding Tax Deposit and Filing Requirements information of the Income Tax Withholding section of this Guide for additional information on personal liability for payment of employment taxes. Limited Liability Company. Liability of the owners of a limited liability company generally is the same as for shareholders of a corporation; that is, absent fraud, personal wrongdoing or disregard of the entity, they generally are not held personally liable for the debts and obligations of the business. They therefore risk loss only up to the amount of their investment. As is the case for corporations, owners of small, closely held, or newly organized limited liability companies may be required to give personal guarantees of repayment to secure financing or credit. 7

15 No Liability Protection for Personal Act. It is important to note that no entity structure will insulate the owner from liability for his or her own personal acts. Distribution of Profits and Losses Sole Proprietorship. The sole proprietor receives all the profits from the business, and bears all the losses, which may exceed the proprietor s investment in the business. Partnership. In the general partnership, the limited liability partnership, the limited liability limited partnership and the limited partnership, profits and losses are passed through to the partners as specified in the partnership agreement. If left unspecified, profits and losses are shared equally among the partners. Corporation. In a C corporation, profits and losses belong to the corporation. Profits may be distributed to shareholders in the form of dividends, or they may be reinvested or retained (within limits) by the corporation. Losses by the corporation are not claimed by individual shareholders. Shareholders include dividends and the gain or loss on the sale of stock or liquidation of stock in the corporation as income. S corporation. In an S corporation, profits and losses flow through to shareholders in proportion to their shareholdings. Shareholders include the gain or loss on the sale of stock or liquidation of stock in the corporation as income but exclude distributions (dividends) received from the S corporation. Limited Liability Company. Profits and losses of a limited liability company are treated in the same manner as a sole proprietorship, partnership, or C corporation based on the federal election of how they decided to be treated. The articles of organization or the board of governors, under circumstances specified in the statute, may provide for a different allocation. Management Control and Decision Making Sole Proprietorship. The sole proprietor has full and complete authority to manage and control the business. There are no partners or shareholders to consult before making decisions. This form of organization gives the proprietor maximum freedom to run the business and respond quickly to day-to-day business needs. The disadvantage of this form is that the sole proprietor, as just one person, will have limited time, energy and expertise to devote to the business. His or her experiences may not provide the breadth of skills and knowledge necessary to deal with all phases of the business. Further, because the sole proprietor is the only person authorized to act on behalf of the business, he or she may be unable to leave the business for extended periods of time without jeopardizing its operations. As the business expands, the proprietor may be able to hire managers to perform some of these functions and provide additional expertise, but in the early years of the business, the sole proprietor often will perform many of these tasks alone. Partnership. The general rule of management is that in both a general partnership and a limited liability partnership, all partners share equally in the right, and responsibility, to manage and control the business. The partnership agreement may centralize some management decisions in a smaller group of partners, but all partners continue to share ultimate responsibility for these decisions. By statute, certain management decisions require unanimous consent of the partners. 8

16 Other decisions may be made by consent of a majority of the partners. The right to share equally in decisions can make the decision-making process cumbersome, and the risk of major disagreements can impair effective operation of the business. An advantage of the partnership that is not present in a sole proprietorship is that the partnership, with its several owners, can bring a broader range of skills, abilities and resources to the business. The owners combined experiences also can promote more informed decision making. In addition, the workload can be shared to lessen the physical and other demands on the individual owners. However, under the Revised Uniform Partnership Act (RUPA), a system of formal filings has been established that allows partnerships to limit the authority of certain partners to third parties as well as to limit the liability of partners for obligations incurred after a partner has left the firm. In order to use this system, the partnership must first file with the Secretary of State an assumed name certificate or limited liability partnership statement of qualification. After that filing has been made, the partnership may again file any of the following statements with the Secretary of State: Statement of Partnership Authority. This allows the partnership to either restrict or specifically expand the authority of particular partners to conduct various transactions, particularly real estate transactions. Statement of Denial. This allows a partner to deny partnership status or the conferral of authority upon the partners by a Statement of Partnership Authority. Statement of Dissociation. This allows a partner who is withdrawing from the partnership to avoid liability for obligations for the partnership incurred after the partner has withdrawn, and also allows the partnership to eliminate the authority of that partner to bind the partnership. Statement of Dissolution. This allows the partnership to notify the world that it is dissolving and that partners will no longer have authority to act on behalf of the partnership. The following are also permitted: Statement of Merger. This allows partnerships and limited partnerships to merge with each other. Statement of Qualification. This statement establishes a Minnesota limited liability partnership under Minn. Stat. 323A. Statement of Foreign Qualification. This statement registers a non-minnesota limited liability partnership. Any of these seven statements may also be amended or cancelled. In order for any Statement to have an effect on real property transactions, a certified copy of the Statement, obtained from the Secretary of State, must be recorded in the offce where land records for the county in which the real property is located, and, if applicable, has been memorialized on the certificate of title for that real property. In a limited partnership in Minnesota, limited partners may participate in the management and control of the partnership but may not act for or bind the partnership. Those functions are performed by general partners. 9

17 Corporation. The rules for corporate decision making are established by statute, but many rules may be modified by the articles of incorporation or bylaws. Shareholders elect the board of directors, which in turn manages the operation of the business. The corporation also must have one or more natural persons exercising the functions of chief executive offcer and chief financial offcer. Except in very small corporations in which the shareholders are also the directors, shareholders as a group generally will not directly participate in management decisions. This concentration of decision making in a relatively few individuals promotes flexibility in decision making, but also can result in overruling of minority interests or in some cases manipulation or exploitation of minority shareholders. To resolve this problem, corporations may adopt provisions in the articles of incorporation or bylaws to give minority shareholders a stronger voice in management decisions. Decision-making authority also may be delegated by the shareholders and/or directors to hired managers, who may or may not be shareholders. This delegation further removes decision-making authority from the shareholders. Like a partnership, the corporation can draw on the skills and expertise of more than one individual in running the business. This can broaden the base of information for decision making and reduce workload demands on individual managers. The articles of incorporation, bylaws or state business corporation act establish procedures and criteria for decision making, such as meeting and quorum requirements, voting margins, and the like, which may make decision making in the corporation more cumbersome than in a sole proprietorship or partnership. Limited Liability Company. Like a corporation, a limited liability company has centralized management. By statute, a limited liability company is managed by or under the direction of a board of governors, comprised of one or more individuals. In addition, the limited liability company must have one or more individuals exercising the functions of chief manager and treasurer. Additional managers and agents may be appointed by the board. The limited liability company act also authorizes members of the limited liability company to make management decisions under certain circumstances. As with a corporation, many of the rules governing the management of the limited liability company are specified in the articles of organization, bylaws, or the limited liability company statute. Financing Startup and Operation of the Business A startup business, regardless of form, generally will find it diffcult to obtain outside financing. The statistical failure rate for new businesses is high, and many lenders view financing the startup business venture as extremely risky. Banks and other creditors generally will require a significant capital investment by the business owner, and a personal guarantee that the owner will repay the loan. Corporations may issue securities to pool capital from a large number of investors; however, the costs of complying with complex federal and state securities laws may be prohibitive, and there is no guarantee that a market will exist for the securities of a new firm. Likewise, limited liability companies may increase capital by admitting more members, but will need to offer prospective members some likelihood of return on their investment. Thus as a practical matter, startup financing for the new venture whether it is a sole proprietorship, a partnership, a corporation or a limited liability company often is limited to what the owner and others closely associated with the venture are able to raise. The discussion which follows addresses the relative ease with which firms with established credit histories may be able to attract financing. 10

18 Sole Proprietorship. The sole proprietor s ability to raise capital generally is limited to the amount of debt he or she can personally secure. Accordingly, the sole proprietorship ordinarily will have less capital available to finance operations or expansion than will other forms of organization that may be able to attract outside investors. Partnership. In most cases, a partnership will be able to raise capital more easily than a sole proprietorship, but not as easily as a corporation. The borrowing power of each partner may be pooled to raise debt capital, or additional partners may be admitted to increase this pooled borrowing power. Or, if the partnership does not wish to distort the ownership position of the original partners, a limited partnership may be established to raise capital. Unlike a corporation, however, partnership assets generally will not be accepted as collateral by a lender. Instead, assets of the individual partners are used to secure loans, which are made to the partners in their individual capacity. Corporation. The corporation generally is the easiest form of organization for raising capital from outside investors. Equity capital may be raised by selling stock to investors. As noted in the section of this Guide on securities registration, the sale of securities is regulated by federal and state laws. Due to the complexity of these laws, the sale of securities is expensive, and the cost may be prohibitive for startup firms. Long-term financing by lending institutions is easier for a corporation to structure because corporate assets may be used to secure the financing. Personal assets of the principals of the corporation and its shareholders also may be used to guarantee loans to the corporation. The number of shares of stock a corporation may issue must be authorized by the articles of incorporation. If a corporation has issued all of its authorized shares, it is necessary to amend the articles of incorporation to authorize additional shares. The amended articles of incorporation must be filed with the Secretary of State, and a filing fee paid. The corporation can avoid these additional costs by authorizing a large number of shares at the time of incorporation. S Corporation. An S corporation is limited by the single class of stock rule and it generally must allocate profits and losses proportionately. This may limit the financing alternatives available to the S corporation. Limited Liability Company. The limited liability company is financed by contributions from members. It also may invest its own funds, borrow money and trade in the securities of other organizations and the government. The limited liability company offers more flexibility in structuring outside financing than does the S corporation. The limited liability company may create multiple membership classes and series, and may provide in its articles of organization that profits and losses may be allocated other than in proportion to the value of a member s contribution. (Tax counsel should be consulted on the tax consequences of a disproportionate allocation.) Limited liability company members may, unless denied in the articles, have preemptive rights to increase their own contributions and maintain their proportion of ownership before the company accepts contributions from outsiders. Also, the articles of organization may need to be amended to allow the limited liability company to create additional membership classes or series of membership interests. Another potential issue in attracting outside financing is that lenders and venture capitalists may not be familiar with the limited liability company as a form of organization. They thus may be unwilling to finance a deal without substantial equity participation and personal guarantees by limited liability company members or principals. 11

19 Transferability of Ownership Interest Sole Proprietorship. A sole proprietor transfers ownership of the business by transferring the assets of the business to the new owner. The prior proprietorship is terminated and a new proprietorship is established under the new owner. Partnership. The transfer of a partner s economic interest in a partnership is determined by the partnership agreement, or by statute if there is no partnership agreement. Unless permitted by the partnership agreement, no person may become a partner without the consent of all the other partners. If a partner attempts to transfer his or her interest in the partnership without such an agreement, the transferee does not become a partner but instead becomes entitled to receive the profits which the transferring partner otherwise would receive. A properly drawn partnership agreement will address the conditions under which an ownership interest may be transferred, and the consequences to the transferee and to the partnership. Corporation. Ownership in a corporation is transferred by sale of stock. A change in ownership does not affect the existence of the corporate entity. Technically, shares of stock in a corporation are freely transferable. As a practical matter, however, the market may be limited for shares of stock in a small corporation that is not publicly traded. In addition, shareholders in a new venture often will want to prevent unrestricted transfer of shares and thus may provide in the articles of incorporation or bylaws for transfer restrictions or buy-sell and redemption agreements, further limiting transferability. In an S corporation, shares of stock are also freely transferable, in theory. However, the S corporation election may be inadvertently terminated if the entity to which the shares are transferred does not qualify as an S corporation shareholder. Limited Liability Company. Membership rights in a limited liability company consist of financial rights and governance rights. Financial rights are the rights to share in the profits, losses and distributions of the limited liability company. Governance rights are the rights to vote and to manage the business. Unless the articles of organization or operating agreement provide otherwise, a member may assign or transfer financial rights. Such a transfer gives the transferee all the rights to profits and distributions that the transferor had. The transfer does not create membership rights in the transferee, nor can the transfer allow the transferee to directly or indirectly exercise governance rights. Governance rights can only be transferred if all members give their written consent. The articles of organization may provide for less-than unanimous consent. Continuity of the Business Following Withdrawal or Death of an Owner Sole Proprietorship. The business entity terminates at the death of the proprietor or if the proprietor becomes unable to manage it. Partnership. General partnerships and limited liability partnerships under the Revised Uniform Partnership Act (RUPA) do NOT automatically cease to exist when a partner dies or otherwise withdraws from a partnership. The partnership continues, unless certain other events occur. A limited partnership does not terminate when a limited partner dies or becomes disabled. The limited partner s interest may be assigned, and if the limited partner dies, his or her legal representative may exercise all the partner s rights for purposes of settling the estate. 12

20 Corporation. A corporation is a separate legal entity, and therefore the death, disability or withdrawal of an owner has no legal effect on the business entity s existence. As a practical matter, however, many small businesses depend heavily on the efforts of one or two individuals, and the death or disability of one of those key individuals can seriously impair the economic viability of the business. For this reason, a small business corporation, like a partnership, often will obtain life insurance on key shareholder-employees. The articles of incorporation may provide for share purchase agreements or other restrictions on the transferability of stock in order to retain control of the firm by the remaining key individuals. Limited Liability Company. For limited liability companies formed before August 1, 1999, the termination of membership of a member by any means is an event of dissolution which generally terminates the existence of the limited liability company. If the articles of organization permit remaining members to give dissolution avoidance consent, or to enter into a business continuation agreement, the limited liability company, or its business, may be continued following an event of dissolution. If at least two members remain following the event of dissolution, and all remaining members unanimously consent within 90 days of the termination of membership, the limited liability company s existence and business can be continued. (The articles of organization may provide for less-than-unanimous consent to continue the limited liability company.) Even if the limited liability company s existence is terminated, if the articles of organization permit it, the remaining members may continue the business by merging the limited liability company into another Minnesota limited liability company or into a Minnesota or foreign corporation. For limited liability companies formed on or after August 1, 1999, the termination of membership of a particular member is an event of dissolution only to the extent specified in the articles of organization or in a member control agreement, or if the membership of the last member terminates and no new members are admitted within 180 days of that termination. Otherwise, the termination of a member s interest does not affect the existence of the limited liability company. Complexity and Expense of Terminating the Business Sole Proprietorship. There are no federal or state regulations governing termination of the sole proprietorship itself. The sole proprietor simply winds up the affairs of the business and discontinues operations. If the business had employees, the owner must notify federal and state taxing authorities that the proprietor is no longer operating the business and paying employees. See also the section of this Guide entitled Business Taxes Income Tax Withholding Withholding Tax Penalties and Interest. The final report of income and expenses attributable to the business is included in the proprietor s individual income tax return, which is filed at the usual time. No final return or early filing is required. Tax consequences may flow from the sale or other disposition of assets used in the business. Partnership. The partnership, because it is a more formal structure than a sole proprietorship, is more complex to terminate. RUPA identifies several ways in which dissolution may occur, but the partners may provide for continuation of the partnership even if an act of dissolution occurs. The consequences of causing the dissolution of a partnership also are specified in RUPA. The statute addresses the allocation and distribution of partnership property upon dissolution, liability of persons continuing the business, and other rights and liabilities of the partners. However, the statute does not address procedural matters such as filing final tax returns, notifying taxing authorities of the termination for employment tax purposes, notification of creditors and similar 13

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